Supply and Demand

As the demand curve dictates how much consumers are willing to buy at certain prices, and the supply curve dictates how much producers are willing to make at a certain price, the market price and volume traded of any good will be determined by both the supply and demand curve. Indeed, such is the importance of this relationship that the supply and demand model is now one of the most fundamental concepts in economics, and any economics student will need a good understanding of it in order to succeed.

The basis of the supply and demand model is that the quantity supplied increases with price, and the quantity demanded falls with price. As such, there will be a point at which the curves cross, and this point will be where the quantity supplied equals the quantity demanded, and the price is the market price. This is usually illustrated on a supply and demand graph, where both the supply and demand curves are shown:

Supply and Demand Curves

As such, this graph shows that there is only one price where the demand is equal to the supply, which is thus the only position in which the market will be in equilibrium. This must be the equilibrium because; if the quantity supplied is less that the quantity demanded, there will be a surplus demand in the market. Producers will be able to make a profit from this excess demand, so they will increase production. In contrast, if the quantity supplied is more that the quantity demanded, there will be a surplus of supply. Producers will be paying to produce these goods, but they will not be able to sell them profitably. As such, they will reduce their production until the surplus disappears and they are making profits again. One the graph above, the equilibrium will occur when producers are supplying 35 units at a price of 25 and consumers are demanding 35 units at a price of 25. For any other amount of price, the market will adjust to move supply and demand back into equilibrium.

In addition, in the supply curve and demand curve sections, it was shown that there are a variety of factors which can affect the supply and demand curve respectively. Any of these factors can act to bring the market temporarily out of equilibrium, and the market would readjust to compensate. For example, if the level of demand increased, the market price would rise as there would be excess demand for the current level of supply. This price increase will lead suppliers to increase their production, as they are able to sell more goods at a higher price. As such, the quantity produced will increase, reducing the market price and forming a new equilibrium with a higher equilibrium price and quantity.

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